HOW BARRIERS TO MARKET ENTRY UNDERMINE BUSINESS GROWTH
Barriers to market entry include a number of different factors that restrict the ability of new competitors to enter and begin operating in a given industry. For example, an industry may require new entrants to make large investments in capital equipment, or existing firms may have earned strong customer loyalties that may be difficult for new entrants to overcome.
The ease of entry into an industry is just one aspect of an industry analysis: the others include the power held by suppliers and buyers, the existing competition and the nature of competition, and the degree to which similar products or services can act as substitutes for those provided by the industry. It is important for business owners to understand all of these critical industry factors in order to compete effectively and make good strategic decisions.
Understanding your industry and anticipating the future needs and directions gives you the knowledge you need to react and control your portion of that industry. Since both you and your competitors are in the same industry, the key is in finding the differing abilities between you and the competitor in dealing with the industry forces that impact you. If you can identify abilities that are superior to competitors, you can use that ability to establish a competitive advantage.
The ease of entry into an industry is important because it determines the likelihood that a company will face new competitors. In industries that are easy to enter, sources of competitive advantage tend to wane quickly. On the other hand, in industries that are difficult to enter, sources of competitive advantage last longer, and firms also tend to develop greater operational efficiencies because of the pressure of competition.
The ease of entry into an industry depends upon two factors: the reaction of existing competitors to new entrants; and the barrier to market entry that prevail in the industry. Existing competitors are most likely to react strongly against new entrants when there is a history of such behavior, when the competitors have invested substantial resources in the industry, and when the industry is characterized by slow growth.
Six Major Sources of Barriers to Market Entry
Economies of Scale
Economies of scale occur when the unit cost of a product declines as production volume increases. When existing competitors in an industry have achieved economies of scale, it acts as a barrier by forcing new entrants to either compete on a large scale or accept a cost disadvantage in order to compete on a small scale.
There is also a number of cost advantages held by existing competitors that act as barriers to market entry when they cannot be duplicated by new entrants – such as proprietary technology, favorable locations, government subsidies, good access to raw materials, and experience in learning curves.
In many markets and industries, established competitors have gained customer loyalty and brand identification through their long-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money to differentiate their products in the marketplace and overcome these loyalties.
Another type of barriers to market entry occurs when new entrants are required to invest large financial resources in order to compete in an industry. For example, certain industries may require capital investments in inventories or production facilities. Capital requirements form a particularly strong barrier when the capital is required for risky investments like research and development.
A switching cost refers to a one-time cost that is incurred by a buyer as a result of switching from one supplier’s products to another’s. Some examples of switching costs include retaining employees, purchasing support equipment, enlisting technical assistance, and redesigning products. High switching costs form an effective barrier by forcing new entrants to provide potential customers with incentives to adopt their products.
Access to Channel of Distribution
In many industries, established competitors control the logical channels of distribution through long-standing relationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of price discounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants.
Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access to new materials, pollution standards, product testing regulations, etc.
It is important to know that barriers to market entry can change over time, as an industry matures, or as a result of strategic decisions made by existing competitors. In addition, entry barriers should never be considered insurmountable obstacles. Some businesses are likely to possess the resources and skills that will allow them to overcome entry barriers more easily and cheaply than others.
Low entry and exit barriers reduce the risk in entering a new market, and may make the opportunity more attractive financially. But in many cases, you would be better off selecting market opportunities with very high barriers (despite the greater risk and investment required) so that you can enjoy the advantage of fewer potential entrants.